Getting Over Oil

Years of cheap oil have slowed energy innovation to a crawl. A new Middle East crisis could change that.

When President George W. Bush announced last May that “we’re running out of energy in America,” students of history could have been forgiven for thinking ruefully of George Otis Smith. Once a formidable figure in Washington, DC, Smith led the U.S. Geological Survey from 1907 to 1930. Just after the First World War, Survey geologists assessed the state of the world’s petroleum reserves-and concluded that they would be totally exhausted before 1940. Alarmed by the prospect of what he called a “gas famine,” Smith charged that the position of the United States “can best be characterized as precarious.”

To stave off an energy crisis, Western nations tried to secure access to the world’s remaining oil, especially the then unexploited deposits in what are now Iran and Iraq. A frantic round of imperialistic dickering ensued, with the United States and France convinced that the British were stabbing them in the back. Disputes over oil spread “a film of mistrust,” historian Herbert Feis lamented, over both the establishment of the League of Nations and the Allied powers’ attempt to bring the fledgling Soviet Union “back into the circle of friendly nations.” Only in the late 1920s did the United States, France, Britain and the Netherlands settle the issue-as far as they were concerned, anyway-by slicing up parts of the Middle East into national oil concessions, thus ensuring their supply of petroleum.

Almost immediately, the whole contretemps was shown to be pointless. Technological advances had changed the oil industry. Using devices for detecting slight variations in gravitational attraction developed by Hungarian physicist Roland, Baron von Etvs, petroleum prospectors looked for the changes in density associated with oil fields-and discovered huge new deposits in Oklahoma and Texas. Texas crude oil was offered for as much as $1.85 a barrel in 1926; by 1931, some desperate producers were unloading it for two cents a barrel. The United States, barely able to handle its own glutted supply, did not actually import Middle Eastern crude for decades. Nonetheless, its willingness to meddle in the affairs of oil-producing Middle East nations helped to sully relations in that part of the world for the next 70 years.

History’s mode of instruction is oracular, rarely providing simple, straightforward messages. Still, certain lessons from the “oil crisis” of the 1920s apply today. One is that even the most authoritative-seeming predictions about energy have a way of missing the mark. “I can’t tell you how many people throughout history have said that in 20 years we’ll have an energy catastrophe,” says David Victor, director of the Program on Energy and Sustainable Development at Stanford University’s Center for Environmental Science and Policy. “And they’ve always been wrong-always.”

The “crisis” also illustrates how the technology and economics of the energy industry are inextricably bound. Baron von Etvs developed his new gravitational techniques at the turn of the century, but oil-company geologists did not try them until fears of a shortage drove up prices. When the baron’s methods were employed, they were so successful that the predicted energy famine became an energy flood.

Today, new energy technologies face similar obstacles. In the midst of President Bush’s claims that the nation is facing a crisis of supply, environmentalists are predicting another kind of energy crisis: global warming. But except for electricity prices in parts of the U.S. West, energy prices have recently been low in historic terms. In consequence, most nations-and most energy companies-have few financial incentives to pursue new technologies, even if they would produce more abundant or cleaner energy. “We’re living in a super price-sensitive and competitive market,” Victor says. “Companies are totally preoccupied with short-term survival. With that kind of mentality, you shouldn’t be surprised that energy research budgets have been on the skids for years.” Indeed, some economists suggest that the best hopes of alternative-energy proponents may come from an unexpected, even abhorrent quarter-that the global tumult created by the terrorist attacks that began last September will in one way or another create uncertainty about energy supplies, perhaps opening up opportunities for new technologies.

Awash in Oil

Will there be an energy crisis of the sort invoked by President Bush? One perhaps precipitated by antipathies in the Middle East? Until September 11, it was widely believed that the likelihood of a calamitous shortfall in supply was much lower than it had been in the past.

Consider the early 1970s, a time of heightened awareness of geopolitical and environmental vulnerabilities. The Club of Rome, an international group of 100 scientists, businesspeople and political figures, asked four political scientists in 1971 to use computer models from MIT to predict the future of the world. The Limits to Growth, in which the results were published a year later, became an international cause clbre that sold nine million copies in 29 languages. Among the study’s major conclusions: the world was going to run out of petroleum by 1992, creating an energy catastrophe.

It didn’t happen, not least because by 1992 the world had already experienced an entirely different kind of energy disruption. Just as the book appeared, several Middle Eastern nations nationalized Western oil companies’ assets. Because the value of the dollar was falling, petroleum prices, then as now denoted in U.S. dollars, also fell. The new owners of the Western oil assets became unhappy. United States support of Israel during the 1973 Arab-Israeli war made them unhappier still. The Organization of the Petroleum Exporting Countries (OPEC), dominated by Muslim nations, embargoed sales to the United States. Oil and gasoline prices shot up.

All of this was terrible for Western nations’ economies. Between the early 1970s and early 1980s, the price of oil went up by a factor of 10. In consequence, U.S. expenditures on energy, as a fraction of gross domestic product, almost doubled, from eight to 14 percent. (These figures, like others in this article, come from the Energy Information Administration of the U.S. Department of Energy.) Rising energy costs helped push unemployment and inflation to record highs; the U.S. economy lurched like an unseaworthy boat from recession to recession. “It was a really awful time,” says Hal Varian, an economist who is dean of the School of Information Management and Systems at the University of California, Berkeley. “When you’re doing economic comparisons you sometimes have to throw out the statistics from those years-the numbers were so freakishly bad, such outliers, that they’re not very useful for normal economic analysis.”

Buffeted by the oil shocks, Americans profoundly-and, it seems, permanently-changed their relationship with energy. Between 1973 and 2000, U.S. energy consumption jumped by about a quarter. But this rise came mostly from the concurrent rise in U.S. population. In fact, U.S. per-capita energy consumption-that is, consumption per American-actually declined slightly from 1973 to 2000. Amazingly, the drop occurred despite the seemingly unslakable U.S. appetite for power-hogging air conditioners, electricity-drinking computers and, more recently, gas-guzzling sport-utility vehicles.

Paradoxically, the United States imports a greater proportion of its petroleum than ever before-but needs it less. In the 1970s, notes Howard Gruenspecht, an economist at Resources for the Future, a Washington, DC-based research group, “the United States used oil for all kinds of things-home heat, electrical power, you name it. Now the great bulk of it is used for just one purpose: transportation.” Oil imports have quadrupled since the OPEC embargo, because U.S. drivers continue to be addicted to petroleum. But oil use has fallen in many other sectors of the economy. At the time of the embargo, for example, almost one-fifth of U.S. electricity was generated by petroleum; today the figure is less than one one-hundredth. In 1973, one out of every four houses in the United States was heated by crude oil; this year it is fewer than one out of ten. With the nation no longer completely dependent on one energy source, the U.S. economy has significantly more resilience against energy shocks than before. “Retail gas prices came close to doubling between the spring of ‘99 and the spring of 2000,” says Pietro Nivola, a senior fellow in governmental studies at the Brookings Institution, a Washington, DC-based think tank. “Consumers screamed about it, but overall, the impact was small, because the whole economy is less dependent on petroleum.”

To the extent that it was intended to increase the geopolitical power of OPEC nations, in fact, the embargo of the 1970s backfired. “The rise in prices made new investments in oil very attractive,” says Fadhil Chalabi, director of the Centre for Global Energy Studies in London, who was the acting secretary general of OPEC for much of the 1980s. “Oil companies found huge new supplies of oil in places like west Africa, the Caspian Sea, the North Sea and Mexico.” The flood of new oil put the traditional OPEC nations-especially Saudi Arabia, by far the cartel’s dominant producer-in an awkward position. To keep prices high, Saudi Arabia and neighboring Persian Gulf states had to cut production. But when they cut production, they lost the income from selling oil. They were losing money so that others could profit. In the mid-1980s these nations lifted the limits; oil prices sank.

But it may have been too late, if Chalabi’s perspective is correct. Like the United States, the West as a whole had become less reliant on petroleum in general and Middle Eastern petroleum in particular. “Even in Europe, the dependence on gulf oil has fallen dramatically over the last 20 years,” Chalabi says. “Europe has gone from importing 70 percent of its oil from the Persian Gulf to less than 30 percent because of the increases in North Sea oil and oil from west Africa.” Worse from the OPEC perspective, any attempt to raise prices will accelerate the transition away from oil to natural gas, coal and nuclear power.

Noting these factors, both the U.S. Energy Information Administration and the International Energy Agency (a Paris-based group with representatives from 26 nations) project that oil will flow in the future like never before. Desperate for hard currency, new Caspian Sea oil centers like Russia, Azerbaijan, Kazakhstan and Turkmenistan have opened the spigots wide; unable to stop them without shutting themselves out of the market, Persian Gulf oil states watched prices fall to a two-year low in November. Iraq, which has been more or less at war with the United States for a decade, nonetheless sells it 613,000 barrels of oil a day. It would like to sell more-Saddam Hussein needs the cash. “It used to be believed that overwhelming demand will make us run out of oil,” Chalabi says. “In fact, the real question is whether there will be enough demand for oil to use the supply.”

Playing Chicken

Continued low energy costs as far as the mind can envision-what could be wrong with that? Anti-global-warming activists know the answer: it’s hard to launch novel energy technologies when the old methods are cheap, even if the new techniques would provide important benefits. Indeed, if history is any guide, the biggest obstacle to a technical solution to climate change may not be devising mechanisms to reduce carbon emissions, but making them cheap enough to compete in the market.

According to United Nations estimates, the United States, which has one-twentieth of the world’s population, is responsible for more than a quarter of the carbon dioxide pumped into the atmosphere every year-about 5.6 billion metric tons in 1999, the latest year for which estimates are available. About a quarter of that total, 1.5 billion metric tons, came from energy. (The rest is due to a variety of sources ranging from cement production to agriculture to termites.) The great majority of atmospheric scientists believe that these carbon emissions will lead, sooner or later, to climatic change. If and when the greenhouse effect substantially heats the planet, U.S. energy consumption will bear a disproportionate share of the blame.

The problem is that curbing these emissions would have a disastrous impact on economic growth. When activists decry global warming, they often single out the American love affair with driving for special opprobrium. But the automobile is far from the only culprit. In 1999, the use of energy by industry released almost exactly as much carbon dioxide as did the national fleet of cars, trucks, planes and sport-utility vehicles; households emitted almost two-thirds as much. Coal-fired electricity plants, gas grills and ranges in the home, agricultural and timber wastes-the list of greenhouse producers is as varied as postindustrial society itself. (Nuclear power plants are an obvious exception, but activists view them, rightly or wrongly, as posing other unacceptable risks [see “The Next Nuclear Plant”]; hydroelectric dams create their own ecological problems.)

Finding ways to curb emissions in all of these areas is a “sobering prospect,” says Paul Joskow, an energy economist at MIT. “With the best will in the world, it’s difficult to see as a practical matter how it could be done.” And with oil prices falling to $17 a barrel last fall-and billions of dollars already invested in the nation’s petroleum-based infrastructure-there are few economic motivations for adopting new technologies. Take fuel cells, for example. Energy researchers like fuel cells because they are silent, efficient, have no moving parts and produce no direct carbon emissions. Unfortunately, fuel cells also have drawbacks. They typically have to warm up, sometimes for as long as half an hour. Worse, the hydrogen in fuel cells is usually stored under high pressure, creating the risk of a Hindenburg-like fireball (see “Fill ‘er Up with Hydrogen,” TR November/December 2000).

But even if these and other technical challenges can be overcome, proponents of fuel cells will still have to convince ordinary Americans to replace their internal-combustion cars. When horseless carriages appeared on the scene, people could get around more conveniently: it was much easier to drive into a city and park a car than to ride there and find lodging and food for a horse. By contrast, fuel cell cars provide exactly the same service as gasoline cars except for producing less of an invisible, odorless gas. Moreover, they will cost more than regular cars, at least in the beginning. Yet even if consumers take the plunge, they won’t actually be able to drive anywhere unless businesses simultaneously spend billions of dollars establishing a network of hydrogen dealers with as wide a service area as today’s profusion of gas stations.

As fuel cells show, new energy technologies always face what Jostrow calls “a classic chicken-and-egg problem.” To attract consumers, fuel cell vehicles must cost the same as or less than conventional automobiles. But that can’t happen until enough hydrogen vehicles have been sold that manufacturers can lower prices. The same is true of hydrogen filling stations-they won’t be present in sufficient abundance until a lot of fuel cell cars are on the road, but fuel cell cars can’t be on the road in numbers until companies put up hydrogen filling stations.

Similar problems affect most new technologies, says Stanford’s Victor. “To replace coal-generated electricity with wind farms-even if that was technically feasible-you’d still have to build the wind farms,” he says. “You have to learn how to design them, how to operate them, how much redundancy you need in the system. That’s all additional costs. Meanwhile, you already have the coal plants.”

Cost of Change

To environmentalists, the economic obstacles faced by new energy technologies are maddeningly unfair. The reason is that the costs of global warming-unlike costs such as labor, insurance and raw materials-are not included in the price of energy. In other words, the price of the kilowatt-hours that heat U.S. homes includes the power company’s cost of fighting lawsuits brought by environmental groups, but not the potentially enormous costs to society from climatic change. Economists, for their part, readily agree that this is a problem. Unfortunately, it is not clear what to do about it.

In economic terms, these unaccounted-for items are known as externalities-costs or benefits that are not adequately reflected in market prices. The problem of incorporating externalities into prices has long bedeviled economics. (Textbooks on externalities were published as long ago as 1917.) A classic example of the awkwardness of handling externalities is the case of the small business that releases a blast of noxious gas and damages its neighbors’ property-wrecking the paint on cars and houses, say. All 50 states have enacted private- and public-nuisance laws that permit individuals and the government to take the offenders to court and force them to pay for the cleanup. If that doesn’t stop further emissions, injunctions can follow. Eventually, in theory, miscreants realize that they can’t avoid legal action and choose to stop polluting, presumably passing the costs of using cleaner technology on to consumers. In this fashion, pollution abatement becomes incorporated into the market price. But as almost everyone agrees, the methods for doing it-lawyers, litigation and legislation-are halting and slow.

Global warming, alas, fits poorly even within this awkward framework. To begin with, much of the problem is due to entire societies, not specific corporations. And because nobody knows the rate at which global warming will occur, or precisely what the effects will be when it takes place, there’s no simple target to shoot for. Global-warming activists often suggest a “carbon tax” on fossil fuels to account for the future costs of climate change. Fair enough, but how high will those costs be? If U.S. consumers pay $1 billion a year, would that be enough to cover the problem? How about $10 billion? $100 billion? The level of economic damage that might be inflicted by greenhouse gas abatement is so uncertain that even the Kyoto treaty on global warming, to date the most ambitious attempt to address climate change, says not a word about what the “right” level of emissions should be.

Compounding matters, the political system has shown little inclination to wrestle with the problem of greenhouse gases. Bill Clinton, arguably the most green-friendly president in decades, refused even to submit the Kyoto treaty to the U.S. Senate. Notoriously, one of President George W. Bush’s first acts of office was to abandon the Kyoto treaty-without feeling it necessary to present any alternative proposal.

Even energy research has hit hard times. According to James J. Dooley, an energy researcher at the Pacific Northwest National Laboratory, U.S. public and private investment in energy R&D have been declining steadily for 20 years. Between 1979 and 1999 public energy-research spending fell by more than two-thirds in real terms. And every other developed nation except Japan has also cut research funding. “With few exceptions, energy R&D simply isn’t on the radar,” he says.

“Look at the projections,” says Dermot Gately, an economics professor at New York University. “Cheap petroleum forever. Cheap natural gas. Cheap coal forever-the United States is the Saudi Arabia of coal. It’s energy Nirvana. Almost every solution to climate change involves driving up those wonderfully low prices. Where’s the mandate for change in that?”

Without clear economic benefits, technological change is most likely in niche markets. An example is the current tests of natural-gas engines in taxi fleets in Long Beach, CA, Atlanta, New York City and other cities. New Zealand, too, has switched most of its taxi fleet to natural gas. (Natural gas burns more cleanly because it is chiefly composed of methane, a simple molecule whose combustion produces carbon dioxide and water vapor but almost no soot or sulfur dioxide [see “Hitting the Natural-Gas Jackpot”].) Why taxis? Urban air pollution is disproportionately due to taxis, which run constantly, under the most taxing traffic conditions. In addition, taxis, which are confined to particular cities, don’t need a nationwide network of alternative-fuel stations.

“The idea in all of these things is to come in from the margins to the center,” says Stanford’s Victor. “But it’s never easy.” Once the technology has penetrated the niche, engineers can work on bringing the costs down. For those who want clean energy fast, though, the best hope in Victor’s view “is for what people now like to call a disruptive’ technology-something that forces huge change. But those don’t happen often.”

Curiously, Gately suggests, innovators may take some heart from the historical record. “We’ve never been good at predicting energy supplies,” he points out. “Something always happens.” Although he, like most energy economists, thinks it unlikely that an event like a terrorist attack could have a long-term, significant impact on energy supplies, he says it’s “prima facie foolish” to discount the possibility of catastrophes in the Middle East or the Caspian Sea. The energy industry can be incredibly volatile-recall that in the five years between 1926 and 1931, the price of Texas crude fell more than 98 percent. In our own day, utilities that spent the summer of 2001 wrestling with electricity price spikes in California spent last fall trying to gauge the impact of war in Afghanistan on the nearby, oil-rich nations around the Caspian Sea. If the U.S. campaign against terrorism creates an explosive reaction, the regime of low oil prices may collapse. Imagine, for example, the effects of terrorist attacks against key pipelines or oilfields. “In one way or another,” Gately says, “we’ve been fighting [in oil country] since Desert Storm. You have to ask, would Americans be more willing to think seriously about energy if, God forbid, something unexpected happened over there? Would they maybe start thinking about fuel cells and carbon taxes? It’s always possible.”

So the silver lining of tumult in the Arab world might be a greater willingness to address global warming? “I wouldn’t put it that way,” Gately says. “I’d say that the crystal ball is as murky as ever. And since we don’t know the future, you can’t rule out the possibility of a happy outcome.”